A:

Holding an option through the expiration date without selling does not automatically guarantee you profits, but it might limit your loss. For example, if you buy a call option for stock A, which currently trades at $90, a decision has to be made as to whether to exercise the option at its expiration date, sell the option or let the option expire. Let's say the stock price goes up to $100 and the option cost is $2. If a decision is made to exercise the option, then the profit that would be made is $100-$90-$2 = $8.

It is important to remember that some types of options permit the holder to exercise the option at specific times. An American-style option has no restriction. It can exercised at any time between the purchase date and the expiration date. A European-style option, however, can only be exercised at expiration and Bermuda options have specific periods when exercise is permitted.

If the decision is made to sell the option, then the profit made may be slightly higher. If the option is sold before expiration date, then implied volatility and the number of days remaining before expiration may increase the price of the option. Let's assume that the price is higher by 10 cents. The profit made will be $10.10 - $2 = $8.10. The decision to sell the option assumes that it is in the money. If the option is out of the money, then exercising the option makes no sense at all because money will be lost if the stock is sold on the market.

One scenario that calls for letting the option expire occurs when you are holding a short position on an option that is out of the money. If you are short a put option that is worth $2, closing the position will cost you $2 plus commission. However, letting the option expire will only cost you $2. In this case, no profit is made, but losses were limited.

To learn more, check out our Options Basics Tutorial.

This question was answered by Chizoba Morah.

http://web.streetauthority.com/terms/options/3.asp

RELATED FAQS
  1. Can an option be exercised on the expiration date?

    The use of options has increased dramatically over the years as a way to profit from or hedge against the volatile movements ... Read Answer >>
  2. How can derivatives be used to earn income?

    Learn how option selling strategies can be used to collect premium amounts as income, and understand how selling covered ... Read Answer >>
  3. How are call options priced?

    Learn how aspects of an underlying security such as stock price and potential for fluctuations in that price, affect the ... Read Answer >>
Related Articles
  1. Trading

    Exploring European Options

    The ability to exercise only on the expiration date is what sets these options apart.
  2. Trading

    4 Reasons To Hold Onto An Option

    There are times when an investor shouldn't exercise an option. Find out when to hold and when to fold.
  3. Trading

    American Vs. European Options

    These two options have many similar characteristics, but it's the differences that are important.
  4. Trading

    Three Ways to Profit Using Put Options

    A brief overview of how to profit from using put options in your portfolio.
  5. Trading

    What Drives An Option's Price?

    The primary drivers of an option’s price are the underlying stock’s current price, the option’s intrinsic value, its time to expiration and volatility.
  6. Investing

    American Vs. European Options—Key Differences

    There are four key differences between American- and European-style options.
  7. Trading

    Exploring The World Of Exotic Options

    Exotic options provide investors with new alternatives to manage their portfolio risks and speculate on various market opportunities. The pricing for such instruments is considerably complex, ...
RELATED TERMS
  1. Call On A Call

    A type of compound option in which the investor has the right ...
  2. American Option

    An option that can be exercised anytime during its life. American ...
  3. Expiration Date (Derivatives)

    The last day that an options or futures contract is valid. When ...
  4. Bermuda Option

    A type of exotic option that can be exercised only on predetermined ...
  5. Early Exercise

    The exercise of an option prior to its expiration date. Early ...
  6. European Option

    An option that can only be exercised at the end of its life, ...
Hot Definitions
  1. Private Placement

    The sale of securities to a relatively small number of select investors as a way of raising capital.
  2. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  3. Backward Integration

    A form of vertical integration that involves the purchase of suppliers. Companies will pursue backward integration when it ...
  4. Pari-passu

    A Latin phrase meaning "equal footing" that describes situations where two or more assets, securities, creditors or obligations ...
  5. Interest Rate Swap

    An agreement between two parties (known as counterparties) where one stream of future interest payments is exchanged for ...
  6. Custodian

    A financial institution that holds customers' securities for safekeeping so as to minimize the risk of their theft or loss. ...
Trading Center